A Way to Recoup Financial Planning Fees: A Strategy for Advanced Investors

A Way to Recoup Financial Planning Fees: A Strategy for Advanced Investors

The old tax write-off of the cost of professional financial advice, long enjoyed by investors in hedge funds and other advanced mechanisms, is history.

The resulting disgruntlement has been addressed and strategies are now available for top-flight investors to mitigate some of these often-considerable costs.

The Tax Cuts and Jobs Act of 2017 is still casting ripples through the financial industry. The law partially quashed the old miscellaneous itemized deduction for investment and financial planning fees if those fees were greater than 2% of the filer’s income. Some clients may still be able to enjoy the deduction, but among sophisticated, high-net-worth customers, tears have been observed and solutions demanded.

These high-level clients are usually arms-deep in hedge fund activity and private equity markets. In the old days, the deduction for financial planning fees could lead to meaningful tax savings. While the full measure of tax assuagement would be difficult to recover in current conditions, a plan has emerged that could materially help advanced investors come April 15.

Financial advisory firm RSM US has a plan for its advanced investors, who are also some of its most lucrative customers. Certain advisory fees, financial, legal or tax related, for example, can be capitalized – that is, added to the cost of the related asset on purchase. When the asset is sold, the tax bill would be reduced. What does the IRS say about RSM’s strategy?

Surprisingly, as far as we can tell at this point, the tax authority’s views seem to align with RSM’s. In 2003, based on legal decisions dating to the 1980s, the IRS issued regulations supporting the capitalization strategy that RSM is proposing. A company executive declared the IRS’s position as “absolutely the right answer as a matter of tax policy.” It’s rare to see tax bureaucrats and financial professionals in agreement, but the IRS, which will have the final word, has not yet commented specifically on the company’s new proposal.

Advanced investments can be dazzlingly complex and involve substantial amounts of capital. Investors with the funds and savvy to participate require a regimental-scale force of experts to help them choose wisely. These third-party professionals are an essential, if costly part of the process. Capitalizing this expense into the final asset price should appeal to investors who, no matter how daring, generally crave prudence when out on a limb.

The benefit comes when the investment is finally sold. With the advisory fees tacked onto the original asset price, the realized gain is reduced, thereby creating a tax advantage. Consider this case: an investor pays $1 million for an asset and adds $100,000 in expenses for financial advice, legal opinions, accountancy services and so on onto the price. She later sells the investment for $1.5 million; well done. The taxable portion of the sale is now $400,000, versus $500,000 if the professional fees had not been capitalized.

Finders fees can also potentially be capitalized under this strategy, useful for investors who find assets via third-party agents and advisors, as well as managed accounts and partnerships.

RSM’s strategy isn’t a panacea: for example, the cost of advice on deals that never go through cannot be recouped. And while the company is sanguine about the IRS’s response, their request for clarification has not yet been answered. While the signs are hopeful, while the tax authority remains mum, we can be forgiven for a measure of unease.

In the post-reform world, other strategies have been floated to achieve like-minded goals. The IRS’s response has been positive in some cases, and aggressively oppositionist in others. RSM’s workaround offers promise to sophisticated investors, but even for mere mortals, the way the case plays out should be interesting.

For more information, please read:
Investors seek tax savings for fees they can no longer deduct | OnWallStreet

Cavalier Associates' Operational Readiness Relative to the Coronavirus/COVID-19 Nine Paths to Better Client Service in 2020